Tax Loss Selling
We are approaching June, and it’s a good time to start talking about tax loss selling in stocks.
It is something that we should all think about in May rather than June. It works like this:
Assuming you pay capital gains tax - many of you don't - on June 30th the tax man will freeze your portfolio, add up all the capital gains you've made this year, all the capital losses, offset the losses against the gains, and come after you for CGT on any net profit.
If your accountant hasn't reminded you, then this is a reminder that you can minimise ('defer' really) your capital gains tax (CGT) liability this year by realising some losses as well as gains before the year-end, rather than just holding on. Basically, if you have a net capital gain from stocks sold, or any other capital gain, you should now be looking through your collection of current holdings for any stocks with losses attached (that you could sell now), and in so doing crystallise a loss that can be used to offset any gains made during the year. In so doing you can minimise your need to pay tax this year. Ultimately, it is not about
how much tax you pay, that will not change. It is about
when you pay it. It's obvious stuff.
Capital losses can offset capital gains.
But of more interest to investors than the tax situation, and what you may not know, is that this process of tax loss selling impacts share prices. In particular:
- Stocks that have not performed well over the year, stocks in which a lot of shareholders are holding at a loss coming into the financial year end, tend to get sold down again towards the end of June. Thanks to tax loss selling, bad performers perform badly in June.
- Small illiquid stocks, ones that have not performed well where again, a lot of shareholders are likely holding at a loss, can get absolutely massacred by tax loss selling in June because the selling is forced through when the liquidity is not there. Net result, if you hold an illiquid stock that is running at a loss, take the loss early, because if you wait until the end of June when every other dodo wakes up to it, you'll be selling into a last-minute frenzy.
If you do want to take a loss before the end of June but want to continue holding the stock long-term, it is a good idea to take the loss early (now for instance), and not buy it back immediately, but wait until the other tax loss sellers destroy it. If all goes well, you can buy it back lower down as the liquidity issue bites the share price closer to the financial year-end.
Even if you don’t have tax issues, thanks to tax loss selling,
trading opportunities can arise, especially in the small illiquid stocks that get massacred. Once the tax loss selling fades away, sold-down stocks can bounce significantly as small buy orders rebound the prices. So traders should be looking for the lows in small illiquid sell-offs over June, hoping for a rally into July. But another word to the wise, whilst you might think you should wait until July 1st to buy, experience suggests that many of the stocks impacted by tax loss selling tend to bounce before the year-end, a week or so before. So for a trader, the game is to identify the stocks getting destroyed and watch for the first rally, rather than July 1st, to get stuck in. The rebounds can be just as sharp as the last-minute drops. Hesitate and you'll miss it.
Marcus Today contains stock market education, commentary and actionable ideas.
Which Stocks Do You Sell for Tax Reasons?
I could list the worst performer in the last year, but it’s a bit irrelevant. The stocks that you should target are the stocks in your own portfolio. I don't know what they are, you do, and anyway, you may not have a capital gains tax issue. But if you do, it's pretty clear which stocks you need to focus on, it’s the stocks are you holding at a loss. The smaller and more illiquid they are, the earlier you need to sell them and, if you still want to continue to hold the stock long term, the closer to June 30th you buy it back, the cheaper you should get it.
And I know a lot of you are in denial about those short-term trades that became long-term ‘investments’, on all those holdings worth $100 that used to be worth $10,000. A common catchcry is that "there's no point selling". But if you have capital gains, there is a point. They too have value now.
Legal Note: ATO Wash Sales Provisions
If you do decide to take a loss before June 30th but plan to re-adopt one or more of your dogs in the new financial year, be mindful of the ATO’s position on wash sales. If you repurchase the shares you sold very shortly after at a similar price, the ATO will look at that transaction unfavourably, and you may be subject to anti-avoidance rules.
Taking Advantage of the Selling
The only ‘game’ you could play here is as a trader buying the stocks that get pummeled running into the last week of June. Stocks that are trading favourites always have a lot of 'stale' holders. They are killed in June and often resurrected in July. There may be a trade in there, capitalising on other people's laziness (leaving their tax loss selling to the last moment) and mistakes (buying small illiquid stocks that fell over).
Hints for Taking a Loss
It is one of the hardest things to take a loss. So to help with the process, I have developed arguments to persuade you. If you are having trouble taking a loss, are not enjoying your trading, are getting emotional, and the stock is still in your possession... read my reasons for why you should think about letting go of the dogs. You will have put the sell order on before you get to the end:
- If a stock is going down, it is far more likely to continue going down than it is to turn on a sixpence to suit you.
- An early loss is the smallest loss - The further a stock falls, the more intense the selling becomes as higher losses cause more selling decisions, so sell early.
- The odds are in your favour - If you sell 10 falling stocks, it will be the right thing to do in nine cases, but you will only remember the other one.
- Clear the mind - If you sell now, you are no longer exposed, and all you have to do is come to terms with the loss.
- You can buy it back - If you sell now, you can always buy it back – you might even buy it back lower than you sold it, and in the meantime, you have a period of clarity.
- The eye of the hurricane - If you sell now, you enter the eye of the storm and all becomes calm. You have a moment to think and can watch from a distance. You can always choose to enter the storm again, and you will be thinking more clearly and be armed with a plan if you do.
- Would you buy this stock now? - If you are making a loss on a stock, think to yourself... "If I had cash, would I buy the stock now at this price?" If the answer is ‘no’, why are you holding it? Sell it. Most people begin to ‘hate’ the stocks they lose money in... so this argument always works.
- Your state of mind has a value - What would your spouse pay (or you pay) to have you carefree at the weekend, instead of ripping the heads off the kids? Look after yourself. There are not that many weekends in the year (or your life). Don’t ruin too many of them by keeping risky loss-making positions until Monday because you didn’t have the guts to sell them on Friday.
- Averaging down is a mug’s game - If you have money to invest, you should be putting it in the best investment in the whole world. Do you really think that will be the very same stock you have already bought at a higher price and that is falling at the moment? Very unlikely. You already have an exposure... why do you need more of something that has already proved itself to be a dog?
- There is no logic in being emotional about losses - Do what most brokers do with their own shareholdings. They have an Excel spreadsheet linked to live prices monitoring all their holdings and what they are worth. At the bottom of the page is a total of what all the holdings are worth now. That clicks over every second, all day. Up $500, down $500. This figure is the only truth. This is what the shares are worth.
- The price you paid is irrelevant - If it’s gone down, it’s gone down. XYZ stock doesn't 'owe you'... what you paid for it is irrelevant to where it goes next.
- Opportunity cost - Not selling a dog ties up capital that could be employed somewhere more gainfully than in a dog stock.
- If in doubt, sell it - It crystallises a capital loss for this tax year. Why wait until the end of the year to take your losses? Taking losses today could set you up for making and taking gains this year. You can always buy it back once you’ve made the sale.
Hopefully, you hold good long-term stocks and won’t have to take a loss, but when you do, read this again and see if you can get to the bottom of the list before you put the sell order on.
More about the author – Marcus Padley
Marcus Padley is a highly-recognised stockbroker and business media personality. He founded the
Marcus Today Stock Market Newsletter in 1998. Over the years, the business has built a community of like-minded investors who want to survive and thrive in the stock market. This is achieved through a combination of daily stock market education, ideas and activities.
Get access to more market commentary, sign up for a free trial now and become a better investor.